November 5, 2008

TO: SBIC Clients and Friends

FR: Mike Wyatt

Hogan & Hartson, LLP

RE:SBA's new Energy Saving Debentures and Renewable Fuel Capital Investment Program

Pursuant to legislation enacted in late 2007, which became effective only a month ago on October 1, 2008, Congress amended the Small Business Act, 15 USC Secs. 631, et seq., to create (I) a new form of zero-coupon "Energy Saving Debentures" which any new SBIC licensed after October 1, 2008 may issue; and (II) apilot "Renewable Fuel Capital Investment Program" to license a new type of SBIC called a "Renewable Fuel Capital Investment Company" (RFCIC) -- somewhat akin to the former New Markets Venture Capital Companies licensed during the Clinton Administration -- to promote research, development and production of goods and services that generate or support the production of renewable energy "by encouraging venture capital investments in smaller enterprises primarily engaged in such activities". [Sec. 690a(1); emphasis added.]

I. New Energy Saving Debentures.

The new debentures may be issued only by new Licensees (ie, not funds licensed before 10/01/08), and only to finance "Energy Saving qualified investments", defined as debt or equity investments in “small” businessesprimarily engaged in researching, manufacturing, developing or providing products, goods or services that reduce the use or consumption of "non-renewable energy sources" (oil, gas, coal) -- ie, companies that promotethe use and consumption of wind, solar, geothermal, hydrogen, ethanol and certain other biomass fuel usage.

The new debentures will have thefollowing characteristics:

A. 5or 10-year maturities

B. No interest payments or annual charges first 5 years; simple fixed interest thereafter.

C. Issued at a discount (like LMI debentures); and

D. Can be used only to finance “Energy Saving qualified investments.” [Sec. 662.]

Newly-licensed SBICsmay enjoy certain advantages by usingthese new debentures to fund certain energy saving qualified investments, including:

A. The cost basis of energysaving qualified investments in smaller enterprises (those with tangible net worth of $6 MM or less, and $2 MM or less average net income last 2 FYs; or which qualify under certain NAICs code standards) – ie, primarily small start-ups and early-stage concerns -- is excluded from an SBIC's maximum outstanding leverage obtainable from SBA, up to an amount equaling 33% of the SBIC's private capital. This has the practical effect of increasing the SBIC's maximum outstanding leverage by up to a total of 16.7%. However,an apparently hardper-company"Overline" limit of 20% offundprivate appliestosuch investments, which isapparentlynot expandable by SBA exemption.[Sec. 683(b)(2)(D).]

B. The same exclusion applies to the maximum amount of outstanding leverage held by groups of 2 or more commonly-controlled SBICs. [Sec. 683(b)(4)(E).] Thus, a group of such commonly-controlled SBICs could increase their total outstanding leverage, if one of the funds were a newly-licensed SBIC authorized to issue energy-saving debentures.

Note, however, that these possible increases in outstanding Leverage apply only to SBIC investments in "smaller" businesses -- those with not more than $6 MM tangible net worth and $2 MM net income (average after taxes during last 2 full FYs); or which can meet certain NAICs code total revenue or employee-number standards. These are the old (pre-1992) size standards which were tripled in the 1992 legislation which created the equity-type participating securities SBICs. The higher ($18MM/$6MM) size standards remain today for "small" businesses ( which can also qualify under the alternative NAICs code standards.)

We understand that SBA has drafted, and sent to OMB for clearance,newregulations implementing the above legislation,which will be issued as "direct final" regulations (ie, in effectimmediatelywithout notice and comment procedures)in the near future.

II. New Renewable Fuel Capital Investment Program.

In late 2007 Congress also separately authorized SBA to create this newpilotprogram, also effective October 1, 2008,to spur research, development and production of new goods and services which generate or support sources of "renewable energy" -- defined to mean"energy derived from sources that are regenerative or that cannot be depleted, including solar, wind, ethanol, and biodiesel fuels." [Sec. 690(3).] We understand that SBA is drafting regulations to implement this new program, which should be sent to OMB soon for clearance.

Under this new Program, the SBA Administrator may create new "Renewable Fuel Capital Investment Companies" (RFCICs)-- essentially a new form of SBIC --which are to enter into certain "participation agreements" with SBA and issue a new form of zero-coupon RFCIC debentures (not the same as thenewenergy-saving debentures described above for new regular SBICs), which SBA is authorized to guarantee and sell (and which are also similar to current LMI debentures).

The aforesaid "participation agreement" must detail the operating plan and investment criteria of the RFCIC and contain the RFCIC's commitment to invest in "smaller" companies engaged in "researching, manufacturing, developing, producing, or bringing to market goods and services that generate or support the production of renewable energy". [Sec. 690(3).] (The reference to "participation" apparently does not mean that the SBA will participate in a RFCIC's profits.)

The SBA Administrator may also make grants to RFCICs, "and to other entities", of up to $1 MM for “operational assistance to smaller enterprises financed, or expected to be financed, by" the RFCICs. [Sec. 690a(2)(C).]Note the inclusion of potential grants to entities other then licensed RFCICs. Grants cannot be used for the RFCIC's own overhead or G&A expenses. [Sec. 690h(c).] $15 MM is appropriated for the grants for each of FY 2008 and 2009. [Sec. 690p(a).]

To qualify as a RFCIC, a company must:

(1) Be a newly-created for-profit entity, or a newly-formed for-profit subsidiary of an existing entity (thereby contemplating RFCIC "drop-downs");

(2) Have a management team with experience in alternative energy financing "or relevant venture capital financing"; and

(3) Have a primary goal of investment in smaller renewable energy companies as described above in Sec. 690(3).[Sec. 690c(a).]

A potential RFCIC must meet certain application criteria similar to those applicable to a regular SBIC, but also submit a proposal to use grant funds to provide operational assistance to smaller renewable energy companies.

The SBA Administrator can conditionally approve a RFCIC applicant, considering certain criteria including management expertise, geographic need and the applicant's qualifications to meet such need, and the applicant's plans and ability to assist smaller companies. Conditionally approved applicants then have two years to satisfy the requirements for final approval, which include:

(1) Raising $3 MM of private capital from 1 or more investors;

(2)Obtaining certain cash or in-kind commitments to provideoperational assistance to smaller enterprises (similar to prior "New Markets" required commitments).

The Administrator is then to finally approvethe applicant if it meets the foregoing requirements and signs a participation agreement with SBA.

The new debentures which an RFCIC may issue shall:

(1) Have terms of 15 years or less;

(2) Have no front-end or annual fees;

(3) Shall be issued at a discount;

(4)Be zero-coupon first five years;

(5) Be prepayable without penalty after one year; and

(6) Require semiannual interest payments after the first five years.

SBA can guarantee such debentures up to an amount which is 150% of a RFCIC's private capital -- ie,1.5X leverage.

Banks can invest in RFCICs up to 5% of their capital and surplus. [Sec. 690i(b).]